Parex Resource (TSX: PXT) is a Canada-based upstream company. Its operational interest lies in crude oil exploration, development, and production in Colombia. Through foreign subsidiaries, the Company holds interests in onshore exploration and production blocks totaling approximately 2.7 million gross acres.

Revenue Mix

Investment Rationale

• Debt Free Balance Sheet: The group has a strong balance sheet with nil bank debt on December 31, 2020, with a USD 200 million undrawn credit facility, and the group has no plans to utilize this in 2021. The company is debt-free since Q2FY15, which implies strong financial health to fund growth engines through internal accruals and free cash flow. Further, the company is generating consistent shareholder value, with debt-adjusted production per share recorded a CAGR of 19% over the past five years.

Source: Company Presentation 

• Increasing Production while Returning Free Cash Flow to Shareholders: Since the first NCIB in 2017, PXT has repurchased roughly 34 million shares and has returned CAD 645 million to the shareholders. Production increased by 43% (67% prior to COVID-19 in Q1 2020) and working Capital increased from USD 131 million to USD 320 million.

Source: Company Presentation 

• Higher Positive Spread Between ROCE and WACC: Parex Resources has a significantly higher positive spread between Return on Capital Employed (ROCE) and Weighted Average Cost of Capital (WACC). The spread between ROCE and WACC stood at 9%, which depicts management efficiencies in fund deployment. Also, the higher spread between ROCE and WACC shows that the company is generating higher free cash flow, which would bolster the group’s financial position, and the company can fund its futures expansions through self-generated cash flows. 

• Generating Significant Free Cash Flow: The company has consistently generated free cash flow and heading Self-funded industry-leading production growth. Further, the company is offering a free cash flow yield of 7.6%, which is significantly higher and provide a greater margin of safety to the existing as well as potential shareholders. 

• Solid Margins: The company has a huge competitive advantage from the margin standpoint, with an industry-leading margin profile. Moreover, despite a challenging FY20, the company’s reported Net margin for the FY20 stood at 18.7%, which is gigantically higher compared to the negative industry median net margin. The strong fundamentals and balance sheet strength also facilitated the group to report a higher EBITDA margin, with an FY20 EBITDA margin of 58.6%, which is significantly higher than the industry median of 36.90%. Further, the company generated 12% return on invested capital, which is quite higher given the turmoil the oil industry witnessed over the past one year.  

Source: Refinitiv (Thomson Reuters)

• Risk Associated with Investment: The company is significantly exposed to the volatility in the oil prices, as the group witnessed a significant drop in the company's netback, going from near US$ 30/share in 2019 to US$ 10/share for the most recent quarter. If the trend continues or happens again, the company's ability to generate the cash flow for shareholder would drop significantly. Further, The Company's main exposure to foreign currency risk relates to the pricing of foreign currency-denominated in Canadian dollars and Colombian pesos, as the company's functional currency is the US dollar. The company has exposure in Colombia and Canada on costs, such as capital expenditures, local wages, royalties, and income taxes, all of which may be denominated in local currencies.

Financial Highlights: Q3FY20

Source: Company Filing

• During the fourth quarter of FY20, Oil and natural gas production for the fourth quarter of 2020 averaged 46,642 boe/d, a 14% decrease from the fourth quarter of 2019 and an increase of approximately 5% from the third quarter of 2020 as development drilling was commenced in late Q2 and Q3. Further, in the third quarter of 2020 the Company began bringing back additional production from previously shut-in or curtailed fields.

Source: Company Presentation

• Oil and natural gas sales in the fourth quarter 2020 were 49,206 boe/d compared to 59,392 boe/d for the fourth quarter of 2019. The decrease in oil sales volumes was a result of the decrease in oil production and purchased oil purchases/sales over the comparative period.
• During the quarter the group recognised a net income of USD 56.2 million (USD 0.42 per share basic) compared to net income of USD 27.6 million in the previous quarter ended September 30, 2020 and net income of USD 87.2 million (USD 0.61 per share basic) in Q4 2019.
• Further, the company generated an operating netback of USD 24.76/boe (2019 – USD 36.43/boe) and a funds flow provided by operations ("FFO") netback of USD 19.06/boe (2019 – USD 27.89/boe) from an average Brent price of USD 45.26/bbl (2019 – USD 62.49/bbl).
• In the fourth quarter the company reported fund flow from operation of USD 81.6 million (USD 0.61 per share basic) a 43% decrease compared to USD 143.3 million (USD 1.00 per share basic) in Q4 2019; FFO was reduced due to lower sales volumes and lower Brent oil prices.
• Overall, the Company’s benchmark Brent price decreased by USD 17.23/bbl, while revenue decreased by USD 16.05/boe in the fourth quarter of 2020 as compared to the fourth quarter of 2019. The price improvement relative to the Brent crude benchmark decrease is mainly a result of stronger Vasconia pricing (narrowing differential to Brent oil price), partially offset by an increase in wellhead sales as compared to the comparative period.

Source: Company Presentation

• Royalties decreased by USD 3.96/boe as a result of lower crude prices in the quarter. Production costs decreased by USD 0.42/ boe mainly as a result of the depreciation of the Colombian peso and the shut-in of higher cost smaller oil fields in Q2 2020.
• During Q4 2020, the differential between Brent reference pricing and the Company's realized sale price was USD 8.31/boe. The differential to Brent crude during Q4 2020 decreased by USD 1.15/boe compared to the third quarter of 2020 where the differential was USD 9.46/boe. The table below provides a quarter-by-quarter view of Parex’ historical pricing in Colombia:

Source: Company Filing

• Differences between Parex’ realized price and Vasconia crude price is mainly related to quality adjustments, wellhead sale marketing contracts, and timing of oil sales compared to quarter averages.

Natural Gas Revenue and Realized Prices

• Parex natural gas revenues were USD 5.4 million and USD 17.3 million for the three months and year ended 2020 compared to USD 3.4 million and USD 12.6 million in the same period of 2019. The increase in natural gas sales from the prior periods is related to increased natural gas volumes sold from Block LLA-32 and the Capachos block. At the Capachos block, Parex completed a gas processing facility and a related natural gas in-field flowline.

Source: Company Filing

Oil and Natural Gas Revenue

• 2020 oil and natural gas revenue decreased by USD 526.1 million or 47% as reconciled in the table below to 2019. Oil and natural gas revenue decreased year over year mainly due to the decrease in world oil prices and decreased sales volumes of produced oil.

Source: Company Filing

Top-10 Shareholders

Top-10 shareholders in the company held around 26.12% stake in the company. Fidelity Management & Research Company LLC, and Wellington Management Company, LLP are among the largest shareholder in the company and carrying an outstanding position of 7.14% and 2.62%, respectively. The institutional ownership in “PXT” stood at 50.51%, and ownership of the strategic entities stood at 2.48%.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV to EBITDA based Valuation Metrics

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock Recommendation:  Parex Resource is built upon strong fundamentals, with a solid margin profile, generating a higher return to its shareholders and a consistent compounder with strong reserve per share growth backed by asset performance and exploration success.

More importantly, the company's reserves per share adjusted for debt between 2012 and 2020 has increased with a CAGR of 42%. Also, the group is committed to returning capital to shareholders through the NCIB and share buyback program, with a repurchase of roughly 34 million shares and has returned CAD 645 million to shareholders since 2017.

Further, despite the challenging fiscal year 2020, the company generated a Return on Equity of 7.6% against the negative ROE of industry median, which reflects the strong competitive moat the group has created over decades. Also, regardless of COVID-19 led distortion in the oil market and lacklustre demand for energy commodities in the first half of 2020, the group reported a net margin of 18.7% against a negative industry median net margin.

The oil economy is getting back into shape with demand is recovering, and the recent rally in the energy prices reflects the gradual recovery in the energy market; PXT is well-positioned to capitalize on the trend.

Therefore, based on the above rationale, and valuation, we recommend a "Buy" rating on the stock at the closing price of CAD 21.03 on March 18, 2021. We have considered Crescent Point Energy Corp, Vermilion Energy Inc and Ovintiv Inc etc., as a peer group for comparison purpose.

1-Year Price Chart (as on March 18, 2021). Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at March 19, 2021 price as well

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